How Much Money Should I Have Before I Need Advice?

I get this question all of the time. And I understand why. The whole "investment" thing, heck, even the financial planning concept, seems designed for people who aren't worried about whether they'll have to wait until next month to fix the muffler on the aging Honda. Actually, though, this is the wrong question. The right question isn't about how much money you have; it's about how much time you have to grow it. Let me explain...

Imagine a woman who's doing quite well for herself. She's got a good career, saves up a little money every month, and just received a big bonus at work. All of the sudden, she has $120,000 in her bank account. Does she need investment advice? Well, maybe not. Let's say now that what she really wants to do is to buy a house in her favorite neighborhood with her savings. Since she lives in the Boston area, that's going to be about $650,000 (no, really). And she wants to do this within the next 3 years.

This would be a great time for her to pay for a financial plan—she's going to want to think about how the mortgage terms play with her other financial goals, taxes, retirement savings, etc... But if she plans to put all of her money into real estate within the next few years, actual investment advice is pointless. The best she can do is probably an FDIC insured bank account with some sort of interest rate (better yet, at her local credit union to set herself up for more favorable mortgage terms).

Sure, she could put the money in the stock market or into bonds or other investments for the next few years, but no financial advisor worth her salt would recommend it. Why? Because investment in securities (stocks, bonds, funds, private businesses, etc...) works well for the long-term. In the short-term, though, investments are a lot more risky and a lot less likely to be worth the hassle and expense. If the market or business is "down" when the perfect property comes up, she's out of luck.

Now imagine another scenario. Like the first woman, this other woman is on the right track after overcoming some difficulties. She's got nothing in the bank, yet, aside from some emergency funds (and we don't ever want to invest those!). On the other hand, she wants to start putting money away for sometime down the road. She's only going to be able to put aside $50 a month for right now. But she has no intention of touching that money for the next 8 to 10 years, at least. Does she need investment advice? Absolutely.

Thanks to all sorts of affordable investments and investment accounts, she's got a ton of choices in terms of where her money goes. Maybe she needs some sort of tax deferred retirement account. Maybe she'd be better off not deferring the taxes. Maybe she needs one well-managed fund, but which kind of fund works best? How can she avoid unnecessary fees? Sure, she is starting small, but the choices she makes now will have a big impact on how that money grows—or doesn't.

So, don't ask yourself (or your local advisor) how much money do you need before you should get investment advice. Ask yourself what your time frame is for that money. If you've got it for 2-5 years, you should probably be shopping for good deals at your local credit union or bank. If you feel confident that you won't be touching it for at least 5, or better yet, 10 years, it doesn't matter what you've got—it's time to become an investor.

Small Business Realities: What's the Difference Between a 401k and an IRA?

This is one of those questions that pops up routinely. The answer is most important for those of you who own your own business, but it crops up for those who work in small companies, too. So what is the difference between a 401k and an IRA? Well, it comes down to a matter of trust—trust accounts, to be exact.

IRA's are really cheap and flexible

An IRA or "Individual Retirement Arrangement" is just what it sounds like. The account is fully owned and controlled by you, the person who hopes to retire one day. The IRS Tax Code says that, as long as you follow their rules with your "arrangement," they won't ask you to pay income or capital taxes on the money you put in your account until you start taking it out (for more about tax deferral and why it's so great, check "Making Sense of Your Company's Retirement Plan"). The rules here are fairly simple: you need to put the money in a trust for your own benefit. Of course, there are some details, but the banks and brokerage houses have stepped in to cover you there. You can open an IRA account at any average bank or anywhere you would open an investment or stock trading account. And in many cases, it costs nothing to open one. Here is Investopedia's list of no or low-balance IRA account offerings for 2015.

Because the IRS doesn't put many limits on what can go into an IRA account, you can invest in all sorts of things with your retirement money. So, when you do go to choose the bank or broker for your account, check their offerings and ask about things like account management fees or trading fees. We often use different brokerage houses for someone who wants to "sit on" three or four standard index funds as opposed to someone who will be doing more trading.

Use the IRA for you business

Believe it or not, your business can open IRA accounts for your employees instead of a 401k plan. Called a SIMPLE (Savings Incentive Match Plan for Employees), these accounts let you, the employer, contribute money to your employee's IRA accounts without the hassle of a 401k. Cheap, easy and available to any business with less than 100 employees (and no other retirement plan), the SIMPLE only requires you to choose a fixed amount to contribute to your employee's plans—either 2% of her salary each year or a "match" of what she contributes between 1% and 3% of her salary.

The IRA compromise

There is a catch. If you are an ambitious saver, IRA contribution limits might mean that you can't put as much into your account as you like. For 2015 and 2016, your total contributions to both your IRA and Roth IRA can't be more than $5,500 for the year ($6,500 if you are over 55). BUT, if you are contributing to an IRA through your employer's SIMPLE plan, that limit goes up to $12,500 (or $15,500 if you're over 55) per year for 2015 and 2016—and that doesn't include your employer's contribution.

The Great 401k

There are a lot of smaller companies out there that would probably do better with a SIMPLE, but the fact is that 401k's, a type of qualified profit-sharing plan, dominate the U.S. workplace. And there are some good reasons for that. Like the IRA, the 401k is a form of trust account that follows rules laid out in the IRS code  in exchange for tax deferrals.

In this case, though, the rules are more complex and the employer retains a lot more control over what's offered in the plan. And that means some serious compromises for both the employer and the employee.

Employees can only invest their 401k money in what's offered in their employer's plan. If your employer has done a great job sourcing a plan, that should be fine for most people. Historically, though, we've seen a lot of 401k plans that offer expensive and/or limited investments and include high management fees. That leaves employees with a less effective account that can add up to tens of thousands of missing dollars over the course of a career.

Employers also often struggle with their 401k plans. As the employer, you have a fiduciary duty to ensure that the plan is fair and well-managed for your employees. And you have a more complex set of filing requirements so that the government can make sure you are taking that duty seriously. For this reason, it has often been difficult for smaller companies to get a good, reasonably priced 401k plan. Keep in mind that the fees will generally include someone to manage the investments and someone to manage the plan to keep you out of trouble.

Why We Love 401k's

Despite the complexity of 401k's, they remain a favorite even amongst smaller companies. Some of this is just down to the enthusiastic efforts of brokerage houses to sell these plans. But there is a real advantage to the 401k, as well. While the SIMPLE limits employees' contributions to $12,500 ($15,500 if she is over 55), employees can contribute a lot more to a 401k account—up to $18,000 per year for 2015 and 2016 ($24,000 if she is over 55). That extra can mean a lot to the right employee.

The Conclusion

So, which sort of plan works better? As you might expect, it all comes down to the size of the business and the savings ambitions of the employees. If you are an employer, it pays to look at your options. If you go with the 401k, be finicky about the brokerage house or investment advisor you choose—choosing the wrong one can cost you and your employees a lot. And if you are an employee in a small business, don't hesitate to approach your employer if you think there's room for improvement. Most employers don't know any more than you do about retirement plan options and are happy to get better information (especially as it might save her some money, as well!).

If you have more questions about small business retirement plans, send me an email.

High Stakes Learning: why figuring out your investments is so hard

Last week we kicked off the Women & Finance series with a "Stocks & Sushi" stock trading game night in Cambridge. As you might have guessed, the emphasis was on having a good time. Our 15th Floor event room above Kendall Square gave us panoramic views across to Boston, and trays of sushi, cakes and a case of wine meant no one was feeling particularly stressed out about learning anything. But the learning—along with a healthy dose of competition (and a little buttercream frosting)—happened all the same.

Since Thursday, I've had a slew of comments and emails from attendees about how much better they understand their own investments since participating in the game. The game itself is a version of something I used to do with an auditorium full of undergrads when I taught the origins of the modern stock exchange. You can't, in my opinion, really understand how and why stock prices fluctuate (and how bonds work at all!) until you are in the middle of the psychological cauldron that is a marketplace. When the dice send the market into a meteoric rise, you can actually feel the tempting pull of the next big bet or the cautionary tug of anxiety, even though those make-believe shares of "Doctor & Gamble" in your hand are, literally, not worth the paper they are printed on.

So why, if this all quickly becomes clear in the game, do the real investments in our 401k account remain so murky to us? I think the answer has something to do with the stakes of the game.

I once had a conversation with a client about why her teenage daughter seems to magically understand all the bizarre features on her smart phone while my client still struggles with turning the camera on and off. "Think about when you use the phone," I said, "you've got a grocery bag in one hand, your half-drunk coffee in the other and you realize you have to make a quick work call in the two minutes before a meeting starts." On the other hand, her teen is using her phone while waiting in the car with a bag of chips and her feet on the dash. While my adult client has precisely three seconds to get the phone to do exactly what she needs before everything starts to come unglued, her teen can play with every button, slide and touch without worrying about it. She's literally just playing around (and she's not paying for that phone). We don't say this often, but the teenager with the smart phone is in a much better state for learning.

If you really want to learn something, it has to be ok to try stuff out, to take risks, to push random buttons and see what happens. But unless someone's already covering retirement for you (wouldn't that be lovely), you aren't going to feel that relaxed about your actual investments. Which means we need to find ways to make learning about finances a more playful experience. It can be events like stock trading night (no one cried or lost their homes when American Textiles went bankrupt following an embezzlement scandal). Or we could be using all of those apps and game software to make the foundations of our financial system accessible to anyone who wants to understand them. And sometimes the answer is just in the way we present investment choices to people. Frankly, those of us in the financial industry—from actual financial advisors to the agents and brokers handling most of the country's retirement plans—have kept the tension high and the chance for learning pretty low. We are going to need to do better.

In the meantime, we will get going on another Stocks & Sushi night. I'm feeling like "Donut Barn" has some real earnings potential.

Should I keep putting money in this investment? Dollar-Cost Averaging and Time

I got a great question yesterday about the difference between saving and investing. Everyone knows that we are supposed to regularly save money. Most of us who follow a set savings plan have our banks set aside a little bit monthly or from each paycheck just to make sure this is happening. But putting money aside in a savings account is not the same as regularly investing it in a stock, bond or fund. We all know the difference matters. So here are a few things to think about when you are trying to decide where, exactly, the money goes.

Dollar-cost averaging.

This is the auto-pilot of investing, which makes it one of my favorite techniques to recommend to new investors. The old "buy low, sell high" investment advice suggests that you should be analyzing the market every time you buy more units of your favorite stock, bonds or fund—not so realistic if you are putting money aside monthly and don't plan to give up your job for day trading.

Fortunately, dollar cost averaging studies show that you actually do well over time by choosing your fund and buying into it at a regular interval, regardless of the price that day. Some months, you will pay more as the price goes up. Other months, though, you will hit those bargain moments when the price is temporarily down. And in between, you usually take advantage of the general growth in the market.

If you could predict the future, you could always get the lower prices, but since none of us (even the experts) are really good at those short-term predictions, statistics show you are better off to not even try. With this in mind, use the settings in your investment account to automatically invest your monthly savings in a good fund. And don't forget the automatic dividend reinvestment setting, too. We love studies that tell us to do less work.

Volatility and your investment account.

Let's say that you already have money in the investment account and want to keep adding but know that the college tuition bill or house down payment will be coming your way in a few years. This is when you start thinking about volatility.

Volatility is the measure of how often and how dramatically the value of a particular investment tends to change. A mutual fund with high volatility will drop and soar in price regularly. We don't have a crystal ball, but we know that the value of bonds tends not to move very fast while company stocks tend to be volatile. For this reason, financial planners recommend that you start putting more of your money in bonds as you get closer to the time when you need it. After all, you don't want one of those price drops to hit just when the tuition bill comes due.

If you don't have a financial planner to help you figure this out, try creating your own simple version of one—pair a cheap, blended stock fund with a government bond fund. As you get closer to when you need your money, put more into the bond fund. (For more on how to choose a fund, check out this earlier post). Or, you could use a "Target Date Fund."  Target date fund managers assign each fund a target year when the investor expects to start drawing out money. The fund manager gradually shifts the investments as it gets closer to that year. Target date funds and blended funds are only a rough approximation of your needs, but they can be a cheap and viable way to manage things yourself.

Bank Accounts verses Investment Accounts

Almost all of the investment advice you will see on the internet assumes you are going to leave that money in your investment account for a long period of time—preferably 10 years or more. Why? Because we are betting that the economy and its markets will continue to grow bigger over time. The majority of investment professionals have developed their strategies to take advantage of just that fact. On the other hand, we are all pretty much positive that the market's growth is not going to be smooth and easy. In other words, we expect a few dips and crashes along the way. That's where your time problem comes in. If you need that money out in 2 years, you may get hit with the crash but not had time to benefit from the growth. It's a good way to lose some of your hard-earned money.

There are cases in which you are better off to use an investment account than a bank account even if you only plan to put the money in something very safe. College savings accounts and retirement accounts offer tax advantages over regular bank accounts. But if you aren't looking for the tax deferral and you are just putting the money away for a few years, don't overlook your bank. I find that local banks and credit unions often offer you better interest rates on savings accounts and CD's (Certificates of Deposit), so you can squeeze just a little bit more out of that savings.

Follow the plan

The single most important factor in determining you success as an investor is making a plan and sticking to it. Choose your strategy and your investment allocation first. And then let all of those auto-deposit and auto-invest features work for you. I firmly believe that paying for a financial plan at this stage is a bargain for just about anyone. But if you are willing to put in some time and do a little research, you can do this yourself. Ready to start? Begin with this How To Start Investing: Basics for Doing It Yourself.